The Temptation of Integrating a New Opportunity

An opportunity exists, only if you are prepared for it

Dr. Shridhar Lolla
First and early Draft Delhi February, 2014

The Theme: Good times or bad times, there is a tendency to jump at every opportunity without doing full justice to a big enough business in hand. Often organizations try to diversify or open up a link to vertical integration at the first sign of constraint in the current business, only to face bad consequences. Diversification, expansion and vertical integrations require tremendous time, energy and resources of the organization, and should not be done as a knee jerk reaction; the least is expected when the existing business is not fully exploited. Here is a case study based on observed phenomena across industries, be it capital goods, pharmaceuticals, software development, paper industry etc. ____________ Keywords: Strategy, Operations Management, Vertical Integration, Diversification, Jugaad, Control Panel Industry, Electrical Industry If you ever noticed, every facility like a commercial complex, factory, hospital etc. have a space where it receives electric power and then through big boxes called control panels the power is distributed to various parts of the facility. These panels contain a number of switches, protection devices and instrumentation. Control panel builders make these panels from a large number of components often based on specific requirements of the facility. Following the engineering design, the most critical process of making a control panel is its assembly, where whole lot of components are installed and tested. Given the sheer number of components and variety that go into these panels, making them available when they are needed in assembly, is a very complex work. Trying to implement a policy of 'just in time' results into part shortages, while a policy of 'well ahead of time' results into high working capital. Walk into the premises of these panel builders and you would find the assembly area often stuffed with 100s of panels waiting for some or other components. Often these panels are required to be delivered under tough delivery dates, and since they are capital intensive, orders for them are won under tough financial terms that include little advance payment and significant chances of loss in revenue due to delays in deliveries (LD, Liquidity Damage clauses). A dip stick study of the industry revealed that over 80% orders are delivered late making the panel builders loose significant margins in terms of delayed payments and materialization of liquidated damages. Further, a vast majority of the control panel industry is unorganized and the industry resembles closer to construction industry than a power or electrical equipment industry. The 'final' margins are very low, since incoming material cost and labor cost are readily verifiable and squeezable by the customers.
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Like other industries, when asked why the on-time performance is so poor, organizations say, 'Supply of input components are never reliable'. Pointing figure outside, seems to be a standard answer in any supply chain. However, the study reveals that even when the demand is low and everybody is scared of impending recession, the due date performance had never been any better. Logically, during low demand time components would be available readily, as the component suppliers run with over capacity and want to remain in business. It is a different matter that panel building organizations continue to blame unreliable supply of raw material for poor service levels. With the false belief that supply of raw material is always poor and the reality that panel building requires a large number of components, actually quite a few panel builders tried to ensure good availability of input components by building significant component inventory. They of course, found later on that it actually did not improve on-time delivery, instead got their money locked in more inventories in warehouse and more panels kept waiting in assembly area. In fact, the due date performance deteriorated further and lead time elongated without anybody realizing about it. The poor performance of the industry continue to be an enigma. As business in infrastructure sector started becoming tighter and more competitive in the current economic conditions, the problem for panel builders has become rather grave. Caught in the vicious circle of heavy input inventory and deteriorating operational as well as financial performance, some of the panel builders turned to tweaking their business models. Knowing that they have significant stocks of components, they conceived and built new profit center to supply these components to other panel builders and markets. They found it immediately appealing since unlike manufacturing, trading is very easy to do without much infrastructure, value creation and hassle. It came as an afterthought to them that having a sales unit that sells component to external market and also feeds into internal panel building orders is a good idea; a sort of benefit of aggregation. These panel builders were actually making good margins for a couple of quarter on component selling to external market. And when they supplied components to their own panel building factory, it was looking like a classical world of vertical integration. Buoyed by the initial demand and realization, many actually took plunge into full dealership of several key components. Led by the chance of the mythical vertical integration and running the pride of two profit centers, the organizations felt that component sales neutralizes the unknown demand variation in panel building market. The initial success then led to strengthening the sales units of components and then, the substantial increase in stocks in component warehouse was by deliberate design. In some of the panel builders case, the aggregated component inventory actually zoomed to over 500% of earlier situation within a very short time. This of course had led to borrowing external funds and diverting attention of management teams from the panel building business, where their 85% of business was at stake. Very soon organizations realized the big mistakes made in tweaking the business model, as it became evident in financial numbers. For most of such panel builders, revenues of core business started dwindling. The overall performance hardly made headway. And everybody started blaming the uncertainty in the market.
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Actually down the line, inside the operations of these organizations, there was big chaos. The organizations were literally divided into two warzones, each with its own profit motive. Every day there was dilemma whether a set of components be used fulfill a customer order placed for panel building or to the external market. It is an open secret that sales depots work on transfer price basis (arms length) with internal panel building business, but on a market price basis with external market. And since they were being measured on profitability and revenues, employees in sales depots always liked to sell components to external market than to internal panel building factory. However, there was other group of employees and management who had big promises and stakes in panel building business, and was inclined to secure component supply to their customer orders. A simple analysis of strategy showed the blunder made by the organizations which resulted into only bad consequences. Actually, at the first sign of dilemma a few control panel builders divested one of the divisions. Their quick actions brought back their business to growth path. Their logic was simple. Whether it is panel building or sales depot, each business on its own is a big enough business with billion dollars opportunity. It made no sense for them to ride on two boats and dilute their focus (as balancing between the two is not easy, simple and straight forward). Hence, it was a clear strategic choice of deciding what not to do and then accepting with what to do. Did not somebody say, 'Strategy is about what not to do...' There were of course answers to the dilemma in operational tactics as well. For which a few panel builders redesigned their operating model. The new operating model called for significant changes in the order management, organizational policies and measurements so that the two functions worked in harmony. These organizations, who had the courage to invest time in re-engineering their operations, reaped the benefit of 'real' integrated and aggregated model. Of course, a vast majority of the builders did not get the courage to bet on only one business nor to innovate their business model. Such organizations were not able to accept the reality of business dynamics and they continue to struggle day in day out hurting their business prospects. And they still complain that the business environment is not good... the component supplies are still not reliable... _________ What's the key take away from the above case? Closely look at your current business. If it is in a big enough market, then there is big enough opportunity to make money there. One must try to exploit the existing business as much as possible. Vertical integration or diversification should be thought only after full exploitation of existing business or after existing it. Especially during bad or turbulent times, the key for growth of an organization is held in innovating operations. Management must avoid doing anything that diverts attention from the current business and resist the temptation of trying to make money from each and every opportunity. If they need to innovate their business model, it must be done systematically and such innovation must be built on strength of the existing business. Least the business should do under demanding conditions is trying to tweak their business (read Jugaad) unnecessarily. _________________

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About the Author

Shridhar is a business coach, and handholds teams in creating 'built to transform' organizations. He specializes in implementing organizational programs in Business Model Innovation, Focused Execution and Operational Excellence. By qualification, Shridhar is an engineer and holds a PhD from IIT Delhi, India. Early in his career, he worked with ABB, the Swiss power and automation technology leader, where he held leadership positions in R&D, Product Development and Service Business. Shridhar has authored two books on building operational excellence culture in today's business environment. His first book, 'Building Manufacturing Competitiveness - The TOC Way' provides a way to dramatically improve performance of manufacturing industry and thereby, resurrect economic growth in India. His second book, 'The Path - Leveraging Operations in a Complex and Chaotic World' is a semi business novel about improving impact of operations on business results. He is also a co-creator of the game changing book 'Business Model Generation'. Shridhar is also a recognized coach for first generation entrepreneurs and is a part of Indian entrepreneurship ecosystem. Spending the day with operational teams and helping them in revealing hidden capacity is his calling. Shridhar lives with his family in Bangalore, India, and can be contacted at lolla@cvmark.com or +91 94480 70081.

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